Are ETFs a suitable strategy for pension schemes?

Mark Johnson: Exchange traded funds are an exposure tool. They come in a variety of shapes and sizes from different providers. There are now more than 5,000 ETFs available globally.

If you compare that with the number of pooled index funds available, you will see that ETFs give you a degree of granularity that is perhaps not available through other wrappers. There have been certain characteristics in the market here that have accelerated interest in the use of ETFs.

These are trends we saw in the US some 10 years ago. For example, a greater focus on the impact of cost in pension outcomes, a move to increase the governance budget and the possible use of more dynamic oversight structures, and a greater interest in passive strategies as a way for investors to access markets. ETFs play to those on many levels.

One of the significant benefits is that, quite often when you think about segregated accounts, the minimum size someone would want is typically £100m. When you look at investing in an ETF, in most cases you can buy one share, which is typically less than £100

Deborah Fuhr, ETFGI

There are three watchwords in the UK. The first is education: helping investors to understand the utility and role of ETFs. The next would be enablement: how do institutions in the UK access ETFs? The third would be around solutions.

So, having said ETFs are an exposure tool, it is rare that trustees would look simply at exposure to a single benchmark, or a single region, without reference to a broader goal. So how do ETFs fit into a broader construct?

Deborah Fuhr: An important thing for many investors is that ETFs, in Europe, are Ucits funds. That should give people a level of comfort. Many pension funds will look at segregated accounts. They might look at commingled funds.

They might look at just using a standard mutual fund index wrapper or active fund. An ETF is just another way of gaining that exposure. One of the significant benefits is that, quite often when you think about segregated accounts, the minimum size someone would want is typically £100m.

When you look at investing in an ETF, in most cases you can buy one share, which is typically less than £100. I have had one of the UK pension funds ask that question: ‘I have made an allocation; we have not yet had the drawdown to fund the allocation.

Is there something I could use in the interim?’ Clearly, ETFs can be a tool to use as a transition when you are looking at filling that gap. They can be a tool if you feel right now you have too much allocation to something. You can use an ETF to reallocate tactically.

Simon Riviere: Would you say that of the funds that use them, it is tactical rather than core?

Fuhr: It is a mixture. Clearly in the biggest funds it is definitely not a core holding. It would be more tactical. So clearly, what we are finding is – I have heard some of the bigger funds in the UK speak about this – as we have so many political, economic and weather events happening that cause you to think whether you should tactically make an adjustment, you do not want to change your external mandates.

Johnson: In the US, recent research conducted by Greenwich Associates, an independent consulting firm, indicated that institutions there are increasingly using ETFs at the core of their portfolios. I would agree with Debbie that in Europe they are seen very much as a complement to an existing strategy, for some of the reasons Debbie outlined. But in the US, strategic usage of ETFs is prominent.

Peter Martin: Of the 20-odd years I have been an investment consultant, it is only more recently, in the past three or four years, that I think ETFs as a product, as a tool, have been discussed and talked about. If you talked to us four or five years ago, I think we would have said we are aware of them, but it is not part of the toolkit. Trustees should at least be aware that they exist and can be part of their armoury.

Riviere: Has that changed because of the size of the funds, Peter? Are they looking for something different? Or is it because generally we are led by the US?

Martin: No, I do not think we are led by the US. If you remember back in 2006/07, stamp duty was abolished on ETF purchases. So that would have been one barrier gone. I think it is a more gradual awareness of the product and where it is used.

In the current state of evolution, our perspective at JLT is that it is part of the toolkit. It is not what I would call a hot topic. It is a tepid topic at this point in time. You can use it for short-term beta exposures and more tactical decisions. I would say there is more chat about these potential uses, rather than it being used for such purposes. But it is at least part of the conversation.

I get exposed to the markets I want for 50 basis points. As a retail investor that feels okay, but as a trustee it feels expensive 

Jonathan Reynolds, Capital Cranfield

Riviere: I would agree with you. When I have spoken to a few advisers I have said: ‘ETFs: what do you know about them?’ Quite a few of said: ‘I know about them, but I have never advised on them.’

Martin: Yes, we have found that a lot.

Riviere: As far as I am aware, only one adviser on one scheme is actively advising us on these.

Jonathan Reynolds: My feeling is ETFs are fantastic for retail investors. From a trustee perspective, there are several issues. With ETFs you are pretty much guaranteed to undershoot the market because the charges are generally higher for a retail investor. I do not know whether you can match it for institutional investors. As an individual I am happy to wear that.

I get exposed to the markets I want for 50 basis points. As a retail investor that feels okay, but as a trustee it feels expensive. There are other clear issues with it.

As a trustee, I have a statement of investment principles that may well prohibit me in investing in certain ETFs. They have plenty of leverage products which I do not think technically suit a lot of SIPs. 

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